We must maintain transparency in financial statements

With governments and regulators scrambling around trying to appear active, and looking to implement populist changes to rules, and in particular financial regulations, will we see poorly thought out changes having a detrimental impact on businesses and investors? In particular, will changes to accounting rules reduce transparency?

The International Accounting Standards Board‘s (IASB) Conceptual Framework sets out, among other things, the objectives and characteristics of financial statements. It identifies four key characteristics:

• Understandability
• Relevance
• Reliability
• Comparability

Transparency is, in my opinion, important to all four of the above characteristics, but in particular understandability and comparability.

Understandability

Information should be presented in a way that is readily understandable by users who have a reasonable knowledge of business and economic activities and accounting and who are willing to study the information diligently. [F.25]

Comparability

Users must be able to compare the financial statements of an enterprise over time so that they can identify trends in its financial position and performance. Users must also be able to compare the financial statements of different enterprises. Disclosure of accounting policies is essential for comparability. [F.39-42]

So it goes without saying that I wasn’t surprised to hear Sir David Tweedie, head of the IASB, talk recently about ensuring that changes to accounting standards do not result in less transparency for the users of the financial statements, in particular within financial services.

With financial regulators under pressure from governments to do something, an often talked about change is to introduce “dynamic provisioning” or pro-cyclical policies — forcing banks to put aside funds in provision reserves during profitable years to reduce the impact of bad years.

Sir David, and other accountants, are concerned that this sort of accounting, if not implemented properly, could result in “cookie jar accounting” where companies mask their performance in poor years through the use of such provisioning (cookie jar accounting is banned by the SEC for public companies).

What does Richard think about this?

If the purpose of financial statements is to allow users of them (investors and many other groups) to make rational economic decisions “both by (a) helping them evaluate past, present, or future events relating to an enterprise and by (b) confirming or correcting past evaluations they have made. [F.26-28]” (IAS Plus) then it requires the finanical statements to provide a clear picture of the organisation’s performance over the period (Income Statement) and its current financial status (Balance Sheet).

Anything that provides scope for companies to mask their true performance through some creative accounting should be opposed at all costs.

On this basis, I am concerned that the EU will try to exert pressure on the IASB to implement what EU finance ministers want rather than what might be best for everyone (if you believe that the IASB acts in everyone’s best interest). As we saw just last month with the EC proposing to provide substantial funding to the IASB in an attempt to gain leverage and influence over the international standard setters.

What is the point of financial statements if they don’t reflect reality? I don’t see any, do you?